DBRS Downgrades Nordstrom, Inc. to BBB (high) from A (low) on Weaker-than-Expected Recovery in Operating Performance, Trend is Stable

DBRS Limited (DBRS) has today downgraded the Issuer Rating and Senior Unsecured Debt rating of Nordstrom, Inc. (Nordstrom or the Company) to BBB (high) from A (low) and the Short-Term Rating to R-2 (high) from R-1 (low). All trends remain Stable. The ratings downgrade reflects a revision in DBRS’s view of the sufficiency of stabilization and recovery in sales and operating income that would lead to an improvement in credit metrics appropriate for an A (low) rating within an acceptable time frame.

Previously, in April 2016, DBRS confirmed Nordstrom’s ratings at A (low) while acknowledging a notable decline in the Company’s operating performance on account of a challenging environment in the latter half of F2015, which was believed to have been a result of consumers’ temporarily reducing their spending on discretionary apparel in favour of other retail segments, such as home improvement, auto, etc., incident to unusually warm weather. At that time, DBRS expected that sales and earnings would recover sufficiently to support an A (low) rating over the near to medium term. DBRS also stated that weaker-than-expected growth in same-store sales and operating income, and/or improvement in financial leverage that is not supportive of the aforementioned pace could result in a negative rating action over the course of F2016.

Nordstrom’s performance in H1 F2016 reflects the Company’s initiatives to boost sales through various marketing initiatives such as the anniversary sale, promoting its loyalty rewards program and enhancing customers’ in-store and online shopping experience. Consequently, even as Nordstrom’s sales growth has recovered moderately during the second quarter of F2016, the Company experienced a notable promotional environment since H2 F2015 that has resulted in a downward shift in operating (EBITDA) margins, which have fallen from relatively high historic levels of about 14% until F2014 to current levels of about 10% in the last 12 months ending August 2016. As such, Nordstrom recorded an EBITDA of $646 million in H1 F2016 compared with $899 million in the same period of the previous year.

Tracking the decline in operating income and echoing the weaker-than-expected recovery for fashion retail, the Company’s cash flow from operations declined notably in H1 F2016 to $442 million compared with $558 million in the same period of the previous year. The Company’s lease-adjusted debt-to-EBITDAR metric also did not move in the expected direction and deteriorated to approximately 2.8 times (x) at the end of H1 F2016 compared with 2.3x at the end of F2015.

Going forward, in view of the latest market trends, DBRS expects that while consumer spending on fashion apparel will continue to gradually improve over the short to medium term, the recovery is not likely to be strong enough to hold Nordstrom’s credit risk profile at levels within the tolerance range of an A (low) rating. Consumers are expected to remain cautious with regards to their spending on fashion apparel over the foreseeable future, while intense competition in the sector from both brick and mortar establishments as well as online retailers is expected to retain pressure on the Company’s profitability. As such, the prospects of the Company’s returning to high single-digit sales growth rates (which it experienced prior to F2015) and/or to operating (EBITDA) margins at levels close to 14% (that the Company maintained before F2015) in the near to medium term have weakened significantly.

Given the H1 2016 results and DBRS’s near- to medium-term view, DBRS believes Nordstrom is better positioned in the BBB (high) rating category. The trends remain Stable, as DBRS expects credit metrics to remain in a range commensurate to a BBB (high) rating (lease-adjusted debt to EBITDAR in a range from 2.0x to 2.75x) over the foreseeable future in view of the Company’s initiatives to augment sales while cutting costs, and its stated intentions to moderate shareholder returns.

DBRS believes that within a challenging sales and competitive environment for fashion retailers, Nordstrom will continue to benefit from its relatively strong market position as the largest department store in the luxury segment supported by its efficient supply-chain and inventory management, robust reputation for offering a wide assortment of high-quality merchandise, best-in-class customer service and a well-regarded e-commerce platform. As such, DBRS forecasts that Nordstrom’s revenues in each of F2016 and F2017 will grow in the low to mid-single digits, mainly driven by the continuing robust growth of its online sales across banners and steady growth of Nordstrom Rack, while Nordstrom full-price, same-store sales are expected to remain flat. In step with evolving market trends, DBRS has revised its estimate of the Company’s F2016 EBITDA to the range between $1.4 billion to $1.6 billion, down from its previous estimate of $1.6 billion to $1.8 billion made in April 2016.

DBRS believes Nordstrom’s capex in F2016 will moderate to approximately $800 million (versus $1.0 billion in F2015) and expects free cash flow after capex and dividends to be marginally positive. DBRS does not expect the magnitude of any share repurchases to require notable incremental debt in F2016; however, less-than-robust growth in EBITDA should result in the Company’s lease-adjusted debt-to-EBITDAR to be in the mid-2.0x range in F2016 with only a marginal improvement within that range in F2017 (versus DBRS’s previous estimate of the metric improving to about 2.20x by the end of F2016 and toward 2.0x by the end of F2017).

The ratings continue to consider intense competition and the Company’s exposure to shifting consumer trends. The ratings are supported by Nordstrom’s scale and market position as one of the largest department store chains in the United States and its robust reputation for customer service and merchandising.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodology is Rating Companies in the Merchandising Industry, which can be found on our website under Methodologies.

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